Aussie bank credit crunch to trigger mortgage repricing

More on looming out-of-cycle rate hikes today from Deutsche:

Over the past 3 weeks the bills-OIS spread has widened materially, rising by around 20 basis points to reach 48 basis points.

On our estimates a 25 basis point increase in the bills-OIS spread could reduce net interest margins by 2 to 5 basis points on an annualised basis, and impact net profit after tax by between 2 and 4 per cent.

These estimates are prior to any mitigating actions by the banks, such as repricing of business loans and/or mortgages.

A higher BBSW rate is likely to increase the asset yield on certain business loans. We assume one third of corporate/commercial loans and all institutional loans are influenced by BBSW.

Based on several simplifying assumptions, we believe NAB could be most impacted among the majors. This is driven by its higher reliance on wholesale funding versus peers, combined with a higher exposure to SME lending rather than institutional. ANZ would be least impacted due to its overweight exposure to institutional.

Whoever it impacts most is irrelevant. If one hikes they’ll all hike.

Banks are already operating on razor thin profit growth expectations. This wipes them out so loans will have to be repriced. It’s not imminent but if spreads remain where they are then it isn’t far off either, as CS said yesterday:

In our recent article “Credit market tightening could overshadow macro-prudential loosening” dated 23 March 2018 (attached), we argue that:

AUD interbank credit spreads have widened very aggressively, and this widening cannot be explained by conventional macro factors. But we have looked at something unconventional – the excess of credit growth relative to banks’ reported lending standards. We find that when credit growth is excessive, interbank spreads tend to rise, presumably because excessive credit growth brings about default risks. And over the past few years, credit growth has been well ahead of our proprietary credit conditions index. Widening USD LIBOR-OIS spreads may not be systemic – but it is an open question as to whether widening AUD spreads might be.

Regardless of why credit spreads are widening, they are likely to have a negative impact on Australian growth via the cost, and availability of credit.

…This sort of macro environment carries with it de-leveraging risks. And de-leveraging risk undermines the efficacy of naïve value factors. Earnings, dividends and book values stop anchoring asset prices during de-leveraging episodes. Rather, asset prices drive fundamentals. Perversely, higher multiple stocks may actually do well to the extent that they carry strong quality, or defensive characteristics.

Given the Royal Commission is the likely driver of the widening spreads, it has the banks caught in a pincer with rising funding costs but political blow back if they hike rates as an offset.

Two conclusions are obvious:

  • sell banks, and
  • the RBA it going to cut.

Comments

  1. GunnamattaMEMBER

    This chart was being beamed around on twitter last night to compare the funding costs of US and EU banks. I’d have thought the Australian banks would be looking at something more alarming

      • Global USD shortage? I thought USD would be one of the last things to be in short supply.

        Besides, doesn’t China have tons of Treasuries to offload?

      • MediocritasMEMBER

        LIBOR is just a proxy for what’s going on in eurocurrency markets (which are dominated by the eurodollar). The largest international funding source in the world that few seem to know anything about…

        Eurodollars are drying up (hence globally rising interbank costs) because of protectionist US government policy under Trump. First there are the corporate tax cuts which are designed to onshore up to $3 trillion USD parked overseas, hence draining the eurodollar market, secondly there is the growing trade war between China and America. Because international trade depends so heavily on eurodollar flows, to impact one is to impact the other and Trump’s government is impacting both. Thirdly, rising US rates, relative to the rest of the world, also drain eurodollars.

        Australian banks are at the mercy of international factors here and if eurodollar futures keep rising like this, then central banks all over the world are going to have to either raise discount rates, or accept a rapidly expanding balance sheet, filling up with increasingly dodgy securities. Either that, or convince their respective government treasuries to run up a whole lot of public debt to support open market operations aimed at targeting a lower funds rate.

        (No coincidence that Trump signed a 1.3T spending bill to accompany corporate tax cuts).

        [Edit: the above is a little simplistic for brevity’s sake. In reality, a lot of experiments were tried and lessons learned in the 2007/8 crisis, so central bank responses are likely to be more “flamboyant” than briefly described. The Fed tried: ZIRP, IOER, TARP, TALF, MMIFF, AMLF, CPFF, TAF, PDCF, TSLF, $45B/month TSY OMO, $40B/month agency MBS OMO, bilateral currency swaps, QEn, and O/N RRP. Add bail-ins to the mix as the big one to follow.]

  2. AUD falls hard. How do the banks hedge their currency risk with all their off shore funding? Im guessing it would be prohibitively expensive to hedge if the AUD started droppping by more than 10 percent

    • Shouldn’t be expensive – all they would need to do is to go short AUD / long whatever currency the debt is denominated.

      If they failed to do that, the end game could arrive very quickly.

    • People get overly worked up about hedging fx risk. Materially all term borrowings are swapped back to AUD, so the level of the AUD at any given time doesn’t really matter.

      If AUD becomes more volatile, future hedging might be more expensive, but that would affect fresh debt issuances only, so consequences should only be marginal in the short-medium term.

  3. The question is whether the wider spread persists or not. Could be 20 points back down in a couple of weeks, which would be pretty boring.

    • JspitzerMEMBER

      And it could be double again and very exciting. Despite Credit Suisse attempted explanation, the scariest thing is no one has a clue why it is happening. I think it’s likely coming out of China and I think that is more likely to blow up than reverse.

    • MediocritasMEMBER

      Depends on whether the USA and China cool it down in the trade war. With the current crop of world leaders we have, who bloody knows!

      The only thing I feel comfortable trading is volatility. Who knows which direction these clowns take us in. That said, I see John Bolton just got appointed as National Security Advisor, so maybe it was nice knowing y’all. I’m off to the fallout shelter now.

    • Nah, the collapse hasn’t started, yet
      But it will.
      then as you say, there will be no buyers, cos all their ammo will be spent.

      The world’s biggest hedge fund has warned last week’s market turbulence, which helped trigger record outflows from global stock funds, was set to continue.
      “There had been a lot of complacency built up in markets over a long time, so we don’t think this shakeout will be over in a matter of days,””We’ll probably have a much bigger shakeout coming.”
      “Last year equity markets had a free run. But this year we are going from central banks contemplating tightening policy to actually doing it,” Mr Prince said.
      “We will have more volatility as we are entering a new macroeconomic environment.”
      Goldman Sachs, emailed that the market probably still has not hit its bottom.
      “Historically shocks of this magnitude find their troughs in panicky selling,”
      I’ve been amazed at how little ‘capitulation selling’ we’ve seen on the desk .
      The ‘buy on the dip’ mentality needs to be thoroughly punished before we find the bottom.”

      • Jumping jack flash

        “Nah, the collapse hasn’t started, yet
        But it will.”

        Too right. It may take much longer to start than we think is possible, too.

      • jj
        dont misread that, the fall is under way, well under way,
        It cant turn back now
        the crash is when it goes vertical down
        the art is to short just prior to the crash

  4. APRA has already stepped in and reclassified some lending products so banks need to hold less capital. The funding cost/liquidity premium at the bank I’m at have actually gone down.

  5. My mortgage mate was saying anz etc have really cut back on funding development in particular, completely dried up.

    • Yep, they are cutting off supply to ensure the rental market stays as tight as possible.

      Turn off the supply tap while the rate of immigration remains through the roof.

      Lower housing costs come a poor second to maintaining the sky high asset prices and capital gains of a minority.

      It’s not as though we actually want to compete with anyone anyway.

      Just sell off more assets, claims on our future incomes and piles of dirt.

      • No development credit puts all the tradies out of work. Bubble popped!
        The income recession driven by excess immigration means the rock has met the hard place. When your up to your neck in debt, more debt cannot solve your problems.
        The bubble is so large it needs both increasing wages and more people at the same time to sustain it.

      • You’re living in the past mate. The tradies are all 457 imports these days. They live cheaply and send money home….. and they can get on a plane and go home to wait for the next instalment of the boom, brought on my choked supply.

  6. reusachtigeMEMBER

    Malcolm Turnball was right that we didn’t need this Royal Commission (a word close to communism). It’s causing some serious problems. Thankfully our regulators and RBA will counter any issues.

    • “we didn’t need this Royal Commission (a word close to communism)”

      Yes it reminds me of those Stalinist show trials. If they had their way they would take any one who showed any signs of being a go-getter and ship them off to some regional centre where no-one in their right mind would ever buy an IP. Meanwhile the brokers who heroically slice through the regulator’s red tape are blamed for not checking people’s wealth and income before they take a loan. Well guess what Commissioner- the wealth and income come AFTER you see the broker. Work is slavery, debt makes us free.

  7. Even StevenMEMBER

    HnH: I have a suggestion – it would be good if MB contributors (yourself, Leith etc) take the time to clarify how some of the measures such as bills-OIS spread operate and what they mean. I see MB’s role being partly educational.

    MB does an amazing job of breaking down some of the key issues in economics, but perhaps less so in breaking down some of the financial jargon, and it appears to presume a little too much knowledge on the part of its readers. I know Mr Google is always available, but even so…

  8. The widening in Bills-OIS spread is driven by a widening in Bills-OIS in the US. As the Aussie banks fund themselves in the US, the Aussie Bill-OIS has followed.
    The widening is equivalent of a rate hike on businesses of 25bps. Therefore the US just had a 50bps rate hike.
    Bring on a slowdown, Fed says economy is slowing and therefore no more US rate hikes for rest of year.
    Equities to the moon. Buy the dip my friends. Buy the dip.
    Look to buy CBA less than 70, just when everyone else is panicing!

  9. In addition to IR’s, banks are moving on large staff reductions (NAB already signalled …more to follow?), and other cost reductions due in some part to fintech open date regime. I can see the banks winding back costs to stay profitable with branches and workers reduced dramatically. Also, what outcome for the investors with interest only mortgages ending in the future; higher rates if the funding is from offshore..on risk alone. I can’t see that foreign lenders will be that thrilled with the Oz housing house of cards, so I can’t see how the rates would be lower even if the RBA drops rates…we’ve seen the banks act independently before. I think the RBA/APRA have lost control by allowing the current housing (GDP boosting) get to where we are. IMO, they are totally out of touch, or just hoping we’ll get through with a miracle.